Nokia: Just Punched or NOCKed Out?

Nokia’s Corporation (NYSE:NOK) fortunes have been mixed of late. Despite sales of over 4 million Lumia handsets, the company reported a $1b operating loss in Q2. The recent increase in its stock price attributed to insider buying as a confidence boosting measure has not worked; Goldman Sachs Group, Inc. (NYSE:GS) downgraded it to a sell on Friday. Apple (NASDAQ:AAPL) and Android devices have dominated the smartphone market and delivered a strong blow to both Nokia and Blackberry maker Research in Motion (NASDAQ:RIMM). Any hope that Nokia’s partnership with Microsoft Corporation (NASDAQ:MSFT) would help it to recover seems to have faded away following Lumia’s relatively minor impact on the market shares of Apple’s iPhone and Samsung, the largest Android handset maker.

While NOK-US’s revenues have increased slower than peer median, the market currently gives the company a higher than peer median Price/EBITDA ratio and may be factoring in some sort of a strategic play.

The company’s relatively low level of capital investment and below peer median returns on capital suggest that the company is in maintenance mode.

NOK-US does not seem to have the flexibility to raise more debt.

Share Price Performance

Relative outperformance last month is up from a median performance last year.

While NOK-US’s change in share price of -56.3% for the last 12 months is in line with its peer median, its more recent 30-day share price performance of 11.3% is above the peer median. This suggests the company’s performance has improved more recently relative to peers.

Drivers of Valuation: Operations or Expectations?

Price/Book or P/B valuation is a function of the observed operating performance of the company as measured by ROE multiplied by the market’s current implied growth expectation as measured by the P/E. We define Valuation Premium as the difference between the Market Capitalization and Book Value of Equity, and as a proxy for the NPV of cash-flow associated to the Book Equity investment.

Based on the analysis of the relative contribution to the P/B valuation of “Operations ROE” vs. “Expectations P/E”, we quickly garner insight into peers comparative performance and the market’s assessment of their strategies – are they just “Harvesting” the current business pipeline or are investors betting on a strategic “Turnaround”?

NOK-US has a low return and high growth expectation profile relative to peers.

NOK-US’s PE multiple is negative now so EBITDA ratios provide better peer comparisons. NOK-US’s share price implies higher growth than its peer group median (Price to Ebitda multiple of 62.6 compared to peer median of 8.4). The market also seems to expect a turnaround in NOK-US’s relatively low current EBITDA return on equity of 1.0%. The company trades at a lower Price/Book multiple of 0.8 compared to its peer median of 1.4.

Operations Diagnostic

NOK-US has relatively low profit margins and median asset efficiency.

The company’s profit margins are below peer median (currently -10.1% vs. peer median of 6.1%) while its asset efficiency is about median (asset turns of 1.0x compared to peer median of 0.9x).

NOK-US has maintained its relatively low net margin profile from the recent year-end.

NOK-US’s net margin is its lowest relative to the last five years and compares to a high of 14.1% in 2007. Though its net margin decreased to -10.1% from -3.0% (in 2011), its peer median remained relatively stable during this period at 6.1%. Net margin fell 6.9 percentage points relative to peers.

NOK-US’s asset turnover is its lowest relative to the last five years and compares to a high of 1.7 in 2007. Compared to 2011, asset turnover has remained relatively stable for both the company (1.0) and the peer median (0.9). Overall, asset turnover and net margin trends suggest that NOK-US’s ROA at -10.1% is its lowest relative to the last five years and compares to a high of 23.4% in 2007.

Earnings Leverage

Changes in the company’s annual top line and earnings (-3.5% and -166.6% respectively) generally lag its peers. This implies a lack of strategic focus and/or inability to execute. We view such companies as laggards relative to peers.

Sustainability of Returns

Relative to peers, recent returns have eroded versus last five years.

NOK-US’s return on assets currently is less than peer median (-10.1% vs. peer median 3.8%) in contrast with its higher than peer median return on assets over the past five years (7.6% vs. peer median 4.8%). This performance suggests that the company’s operations are eroding markedly relative to peers.

Drivers of Margin

The company’s gross margin of 31.9% is around peer median suggesting that NOK-US’s operations do not benefit from any differentiating pricing advantage. In addition, NOK-US’s pre-tax margin is less than the peer median (-9.9% compared to 9.6%) suggesting relatively high operating costs.

NOK-US has moved to a relatively low pre-tax margin from a Commodity/High Cost profile at the recent year-end.

NOK-US’s gross margin has increased 2.0 percentage points from last year’s low but is still below its five-year average gross margin of 33.0. While its gross margin increased to 31.9% from 29.9% (in 2011), its peer median decreased during this period to 37.2% from 39.2%. Gross margin rose 4.1 percentage points relative to peers.

NOK-US’s pre-tax margin is its lowest relative to the last five years and compares to a high of 16.2% in 2007. While its pre-tax margin decreased to -9.9% from -3.0% (in 2011), its peer median increased during this period to 9.6% from 9.0%. Relative to peers, pre-tax margin fell 7.4 percentage points.

Growth Expectations

The stock price is likely factoring in some chance for a strategic play.

While NOK-US’s revenues have increased more slowly than the peer median (-1.8% vs. 7.4% respectively for the past three years), the market currently gives the company a higher than peer median Price/EBITDA ratio of 62.6 (Note: We use Price/EBITDA instead of PE due to negative earnings). The stock price may be factoring in some sort of a strategic play.

Capital Investment Strategy

NOK-US seems to be in maintenance mode.

NOK-US’s annualized rate of change in the capital of -5.3% over the past three years is less than its peer median of 1.8%. This below median investment level has also generated a less than peer median return on capital of -2.3% over the same three years. This outcome suggests that the company has invested capital relatively poorly and now may be in maintenance mode.

Leverage & Liquidity

NOK-US does not seem able to raise more debt easily.

NOK-US’s debt at 23.2% of its enterprise value compared to an overall benchmark of 25% (Note: The peer median is currently 10.8%), and interest coverage level of 2.1x, would make major new borrowings difficult.

NOK-US has moved towards a median liquidity and leverage from a relatively low leverage profile at the recent year-end.

NOK-US’s interest coverage is similar to last year’s low of 2.1x, which compares to the 2007 high of 161.2x. Though its interest coverage has remained relatively stable at 2.1x compared to 2011, its peer median has decreased to 8.7x from 13.8x during this period. Interest coverage rose 5.2 points relative to peers. It is also below the 2.5x coverage benchmark unlike the peer median.

NOK-US’s debt-EV is its highest relative to the last five years and compares to a low of 1.0% in 2007. Though its debt-EV increased to 23.2% from 16.7% (in 2011), its peer median remained relatively stable during this period at 10.8%. Relative to peers, debt-EV rose 6.3 percentage points.

Key Valuation Items

Company

Market Cap(mn)

Price / Book

Price / Earnings

Dividend Yield (%)

Apple Inc.

577,161.0

5.2

14.5

0.4

Siemens AG ADS

78,768.7

2.0

12.5

3.0

Ericsson ADR

29,033.0

1.4

13.7

2.7

Motorola Solutions Inc.

13,744.4

3.4

28.1

1.4

HTC Corp.

8,696.3

2.6

4.6

14.4

ZTE CORP H

4,622.1

1.2

14.3

2.4

Research In Motion Ltd.

3,662.8

0.4

N/A

0.0

Alcatel-Lucent ADS

2,698.8

0.5

4.1

4.3

Nokia Corp. (ADR)

8,875.6

0.8

N/A

17.4

Peer Median

8,875.6

1.4

13.7

2.7

Best In Class

577,161.0

5.2

28.1

17.4

Revenues & Margins

Company

Revenues (mn)

Gross Margin (%)

Pre-Tax Margin (%)

Net Margin (%)

Apple Inc.

148,375.0

45.8

36.2

27.0

Siemens AG ADS

103,252.8

32.2

9.6

6.1

Ericsson ADR

33,669.8

37.2

10.6

6.7

Motorola Solutions Inc.

8,350.0

53.2

9.8

6.6

HTC Corp.

14,606.9

28.0

14.0

12.0

ZTE CORP H

13,365.8

29.7

3.0

2.4

Research In Motion Ltd.

16,338.0

37.4

(0.2)

(0.3)

Alcatel-Lucent ADS

20,511.0

39.6

(0.4)

3.2

Nokia Corp. (ADR)

45,476.6

31.9

(9.9)

(10.1)

Peer Median

20,511.0

37.2

9.6

6.1

Best In Class

148,375.0

53.2

36.2

27.0

Key Assets (% of Revenues)

Company

Capital (%)

Goodwill & Intangibles(%)

Working Capital (%)

Cash & Equivalents (%)

Apple Inc.

75.3

3.7

13.1

18.6

Siemens AG ADS

64.2

27.1

13.0

15.0

Ericsson ADR

75.1

22.7

43.5

28.6

Motorola Solutions Inc.

67.2

17.6

58.4

45.1

HTC Corp.

23.6

5.3

11.9

18.6

ZTE CORP H

55.8

0.4

22.3

25.6

Research In Motion Ltd.

58.8

20.6

23.1

11.9

Alcatel-Lucent ADS

57.3

38.7

19.0

28.3

Nokia Corp. (ADR)

39.7

16.7

18.7

27.2

Key Working Capital Items

Company

Inventory DSO

Receivable DSO

Payable DSO

Cash Conversion Cycle*

Apple Inc.

2.7

34.5

41.6

(27.1)

Siemens AG ADS

78.3

76.4

34.6

253.8

Ericsson ADR

52.6

138.6

37.4

484.0

Motorola Solutions Inc.

21.5

91.9

27.8

296.7

HTC Corp.

25.1

50.7

61.6

(29.1)

ZTE CORP H

57.6

183.1

123.7

117.0

Research In Motion Ltd.

22.8

74.8

15.7

379.0

Alcatel-Lucent ADS

47.1

79.5

89.9

6.4

Nokia Corp. (ADR)

23.4

81.8

47.6

189.0

Peer Median

25.1

79.5

41.6

189.0

Best In Class

2.7

34.5

123.7

(29.1)

* Inventory DSO Receivable DSO – Payable DSO

Cash Management Indicators

Company

Current Assets DSO

Current Liabilities DSO

Cash Float DSO*

Excess Cash DSO**

Apple Inc.

121.6

73.7

(97.3)

61.8

Siemens AG ADS

256.8

209.5

(63.0)

49.1

Ericsson ADR

315.2

156.6

192.0

106.6

Motorola Solutions Inc.

398.6

185.5

(10.4)

186.3

HTC Corp.

155.3

112.0

(237.4)

64.4

ZTE CORP H

327.1

245.6

2.9

71.3

Research In Motion Ltd.

164.9

80.4

221.2

34.2

Alcatel-Lucent ADS

278.6

209.1

(158.1)

96.0

Nokia Corp. (ADR)

245.8

177.4

(201.1)

96.1

Peer Median

256.8

177.4

(63.0)

71.3

Best In Class

121.6

245.6

(237.4)

34.2

* CurrAssetsDSO – CurrLiabDSO – CashDSO

** Excess Cash = Cash & Eqvts – 2%*Revenue

Key Liquidity Items

Company

Debt/Enterprise Value (%)

Current Ratio

Interest Coverage (x)

Cash Flow To Total Debt (%)

Apple Inc.

0.0

1.6

No interest exp

999.0

Siemens AG ADS

14.4

1.2

4.7

47.3

Ericsson ADR

10.8

2.0

13.8

72.6

Motorola Solutions Inc.

7.3

2.1

8.7

89.1

HTC Corp.

0.0

1.3

1,989.9

999.0

ZTE CORP H

15.1

1.3

1.5

13.5

Research In Motion Ltd.

0.0

2.1

No interest exp

999.0

Alcatel-Lucent ADS

20.6

1.4

0.7

6.1

Nokia Corp. (ADR)

23.2

1.3

2.1

2.7

Peer Median

10.8

1.4

8.7

72.6

Best In Class

0.0

2.1

1,989.9

999.0

Key Cash Flow Items (% of Revenues)

Company

Operating Cash Flow (%)

Capex (%)

Interest Expense (%)

Dividends (%)

Apple Inc.

35.1

4.4

0.0

0.0

Siemens AG ADS

7.5

3.0

1.8

3.2

Ericsson ADR

3.0

0.1

0.8

3.4

Motorola Solutions Inc.

8.2

2.5

1.5

41.0

HTC Corp.

14.9

2.2

0.0

7.0

ZTE CORP H

(4.3)

2.9

1.0

0.0

Research In Motion Ltd.

16.0

5.1

0.0

0.0

Alcatel-Lucent ADS

0.8

3.8

2.5

0.6

Nokia Corp. (ADR)

3.2

1.7

0.8

4.7

Company Profile

Nokia Oyj engages in the mobile communications technology industry. It operates through the following segments: Smart Devices, Mobile Phones, Location & Commerce, and Nokia Siemens Networks. The Smart Devices segment focuses on smart phones and smart devices. The Mobile Phones segment offers mass market feature phones and related services and applications. The Location & Commerce segment includes the development of location-based products and services for consumers, as well as platform and local commerce services for feature phones and smart phones, device manufacturers, application developers, internet service providers, merchants, and advertisers. The Nokia Siemens Networks segment provides a portfolio of mobile, fixed and converged network technology, as well as professional services including managed services, consultancy and systems integration, and deployment and maintenance services to operators and services providers. The company was founded in 1967 and is headquartered in Espoo, Finland.

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